Does the President's Budget Increase the Deficit or Reduce It? (The Answer Depends on Your Baseline)

According to Obama Administraton, the President's FY2011 reduces the ten-year deficit by $2.1 trillion; or $1.2 trillion if the savings from the Iraq war are excluded. Yet according to our analysis, it would increase the deficit by $3.1 trillion. So who is right? Well, it depends on what baseline you use.

The standard way to measure policy change is relative to a "current law" baseline which essentially assumes all policies will continue as written into law. This is the baseline that was established under the Budget Enforcement Act of 1990, and is used by the Congressional Budget Office. It is also the baseline against which all previous iterations of pay-as-you-go (PAYGO) budget rules.

However, the Administration argues that it should be able to measure its policies against a "current policy" baseline. We have constructed one of these in order to show the magnitude of our fiscal problem -- but we don't believe it is the appropriate benchmark for measuring policy change or for adhering to PAYGO.

The Administration's current policy baseline essentially allows $5.2 trillion in adjustments, relative to a current law baseline. The current policy baseline deficit is $10.6 trillion (and $1.3 trillion in 2020) as opposed to $4.1 trillion ($560 billion in 2020) under the current law baseline.

Not that these numbers are different from the $6 trillion and $12.4 trillion under our current policy baseline. This is the result not only of different economic and technical assumptions (ours is based off of CBO numbers), but also because of different policy assumptions. Since there is no consensus on what exactly constitutes current policies, different baselines can differ dramatically.

The Administration's current policy baseline makes four major assumptions. It assumes that the AMT will be indexed to inflation; it assumes Medicare physician payments will not drop by 21 percent this year, as scheduled; it assumes the 2001/2003 tax cuts -- including child tax credit and EITC provisions added by the 2009 American Recovery and Reinvestment Act (ARRA) -- will be made permanent rather than allowed to expire at the end of 2010; and it assumes Pell Grants will be funded sufficiently to continue to pay benefits at the levels set by the ARRA.

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When interest costs are added, the fiscal consequences of the policies in this baseline are enormous. Instead of bringing the deficit down to 2.6 percent of GDP in 2015 (keep in mind, the Administration's target is about 3 percent) and 2.3 percent by 2020, the Administration's current policy baseline will result in deficit equal to 5.1 percent of GDP in 2015, and 5.5 percent in 2020.

Deficits of below 3 percent of GDP are needed to stabilize the debt as a share of the economy. So simply allowing the law to play out as scheduled would stabilize and then reduce the debt-to-GDP ratio, at least over the next decade. Continuing along with "current policy," conversely, would put the debt on a permanently upward path.

That is argument alone for carefully considering which so-called "current policies" we want to continue on a deficit-financed basis, rather than just assuming them into continued existence.